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Recommendation Date : 14-Aug-2010 Last Update Date : NA
Real Estate - Construction :
Expect BSE Realty Index to cross 2008 highs, over 250% increase from current levels.
Staying awake after watching a horror movie, post Lehman most investors have been behaving like that, at-least with the real estate sector. Nothing better can explain The Big Disconnect between strong & improving fundamentals of the sector and the stock prices of the companies in the sector. When majority are fearful, we strongly advise you to be greedy and invest in stocks rather than directly investing in property. While we expect property prices to continue their northbound journey, we see strong appreciation in stocks as they completely missed out last year’s rally. India’s sound macroeconomic environment, huge domestic savings, demographic shift, perennially preferred asset class, limited alternate investment opportunities, scarcity of clear title land are a few of many such factors that make us so confident on the sector. The buoyancy of the sector is evident from the fact that the property prices have not only recovered from their lows but are nearing the 2008 peak prices, even surpassing the highs in many regions. India’s low Mortgage:GDP ratio and the improving connectivity & mass transport system further increases the sector’s potential. The sector is due to benefit from India’s favourable demographics with a fast growing work force. The exploding middle class, breaking up of the ‘joint-family’ system and rapid urbanization all imply greater demand for housing. Also the high private saving rate of over 32% of GDP and lack of other investment opportunities particularly for the huge parallel economy will give a further fillip to the sector. Over the last year a lot of sectors have run up led by the ‘domestic consumption story’. Ironically the real estate sector is still to benefit from the belief despite the sector by its very nature being truly driven by domestic consumption and unlike others it cannot be imported. Stocks Much Better Investment Vehicle than Direct Exposure to Real Estate Real estate companies leaner, stronger & wiser Given sound domestic fundamentals and stronger cash flows from operations we expect the stocks of real estate companies to outperform the market. While a few companies do have high leverage, most of the companies have substantially improved their balance sheet over the last two years. The recovery is evident from the aggressive participation and bidding in the recent land auctions over the last few weeks. Real estate company stocks available at a bargain Most real estate stocks are available at a fraction of their asset value. The current transient irrationality in the stock prices makes them a lucrative bargain buy. There is a clear disconnect between the property prices and the stock prices of these companies. While the property prices are nearing all time highs, the stocks continue to be available at a huge discount. Some stocks can even be bought for less than their book value and many are trading at more than 50% discount to their NAV, even lower than 1/3rd of their historic peaks. Other than the attractive valuations we feel it makes more sense to invest in stocks rather than property because of the NAV growth multiplier - any increase in the prices of a flat has more than proportionate increase in the NAV of the project and consequently of the company’s stock price. Difficulty in getting clear title properties in India, the associated legal hassles and illiquidity further make a case for buying stocks. Also possibility of investing in small quantities, making diversification possible is a great advantage of investing in stocks. Irrationality in stock prices due to unwarranted fears While investors are shying away from the sector due to a few concerns we feel the fears are unwarranted. The anticipated interest rate hike by RBI is making investors believe that the demand for real estate would fall. However we see the rise in interest rate having minimal impact, if any, on the demand. Unlike other countries, the real estate industry in India is not driven by bank / non bank finance, bulk of the purchases being financed entirely from savings with a large ‘cash’ component. This partially explains India’s relatively low mortgage:GDP ratio and the fact that only about 30% of the total realty deals in the country are financed by financial institutions. Unlike most other sectors, real estate is a pure domestic theme which is produced, consumed & sold domestically, global developments in US, Europe, China; et al has only an indirect impact on demand through confidence and capital channel. It’s surprising to see that while all experts & financial gurus are stressing to invest in Indian domestic demand driven sectors, real estate has been given a total miss. While the lukewarm demand and pipeline of scheduled IPO’s by realty companies over the next few months are believed to have reduced investor’s interest in the sector, we believe that given the low market value of the free float stocks in the sector the scheduled IPOs will have minimal, if any impact on the demand over medium to long term.
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